Private equity ownership of insurers: EIOPA’s expectations

Private equity investment in the insurance sector has attracted increasing supervisory attention in recent years. This follows a growing trend of private equity firms acquiring full or partial interests in insurance and reinsurance undertakings, particularly in the United States but also, increasingly, within the European Union.

Private equity ownership can bring clear benefits to an insurance undertaking, including access to capital, a more diverse investment strategy, operational efficiencies and strategic guidance. At the same time, the private equity model may introduce risks requiring closer supervisory scrutiny, particularly where the investor’s intended investment horizon does not align with the long-term nature of insurance liabilities or where the acquisition is followed by material changes to the undertaking’s business model, investment strategy or governance arrangements.

It is against this background that the European Insurance and Occupational Pensions Authority (“EIOPA”) has issued a Supervisory Statement on the authorisation and ongoing supervision of (re)insurance undertakings related to private equity. Its objective is to promote high-quality and convergent supervision across the European Union, covering acquisitions of qualifying holdings, portfolio transfers and mergers, as well as the ongoing supervision of private equity-related (re)insurance undertakings.

Importantly, the Supervisory Statement does not treat private equity ownership as inherently problematic. Rather, it recognises that private equity encompasses a range of ownership structures and investment models and that the risks associated with a particular acquisition will depend upon its specific characteristics. The expectations set out in the Supervisory Statement are therefore to be applied by supervisory authorities on a risk-based and proportionate basis.

Looking beyond the acquisition

One of the central themes emerging from the Supervisory Statement is that the regulatory assessment should extend beyond the identity and financial standing of the proposed acquirer. Supervisory authorities will also be expected to understand how the target undertaking is intended to operate following the acquisition and how the private equity investor proposes to generate value from it.

Private equity investors will ordinarily seek to unlock value by making strategic, operational or financial changes. These may include changes to management or the business strategy, measures aimed at streamlining expenditure, outsourcing arrangements within the wider group or changes to the undertaking’s investment portfolio. In certain cases, the business model may also involve transforming the undertaking into a “consolidator” of insurance portfolios in run-off.

Against this background, the proposed acquirer should provide a complete picture of the changes contemplated following the acquisition. This should ordinarily be supported by a business plan covering a period of at least three years. Where the information provided is considered insufficient, supervisory authorities may also assess whether to request the minutes of the investment committee or board which approved the acquisition.

The assessment will need to consider whether the proposed business model will allow the undertaking to continue complying with its prudential requirements, particularly where the transaction envisages changes intended to improve its revenue or solvency position. Supervisory authorities should also consider whether sufficient and sustained investment will continue to be made in the undertaking’s long-term operational capabilities, including its IT infrastructure and digital resilience.

Where significant risks are identified, conditions may be attached to the declaration of no objection issued in connection with the acquisition. Where significant risks are identified, supervisory authorities may consider mitigating measures, including the imposition of conditions in the declaration of no objection.

A further area of focus is the potential tension between the period over which the private equity investor intends to hold its investment and the long-term commitments assumed by the insurer. A private equity investor may seek to realise its investment within a defined timeframe which does not necessarily correspond with the duration of the undertaking’s obligations towards policyholders and beneficiaries.

EIOPA therefore expects the investor’s capital commitments, intended business plan and proposed exit strategy to be assessed against the longer-term nature of the insurance business. Particular attention should be paid where a mismatch is accompanied by high initial distributions to shareholders, incentives for an early exit or changes to the investment strategy which may not be in the best interests of policyholders and beneficiaries. Where the mismatch is significant, the supervisory authority may ultimately conclude that the proposed business model is not viable.

This assessment does not end once the acquisition has been approved. As the period over which the private equity investor intends to hold its investment draws to an end, particularly where attempts to dispose of the undertaking have failed, supervisors should continue to monitor the financial stability of the insurer. At that stage, the private equity owner’s incentive to provide further financial support may have diminished. The undertaking may consequently be required to reflect potential exit scenarios within its risk-management framework and own risk and solvency assessment.

Independence and effective governance

The Supervisory Statement also places considerable emphasis on the continuing independence of the insurance undertaking. Although shareholder involvement is a normal feature of an ownership structure, that involvement should not prevent the undertaking’s administrative, management or supervisory body from exercising its responsibilities independently and in the interests of policyholders and beneficiaries.

Supervisory authorities should therefore consider whether affirmative voting rights, special shareholder rights or other governance arrangements could undermine the independent exercise of responsibilities by the undertaking’s governing bodies or create unmanaged conflicts of interest. Where shareholder representatives participate in company committees, the purpose, responsibilities and activities of those committees, and their interaction with the persons effectively running the undertaking or holding key functions, may also be examined.

The undertaking’s governing body must collectively continue to possess the expertise and knowledge necessary to manage the insurance business and understand the applicable legislative, regulatory and financial framework. This assumes particular importance given EIOPA’s observation that private equity investors may not always have sufficient local experience in the insurance sector.

Potential conflicts may also arise through intragroup arrangements, including asset-management, reinsurance and outsourcing agreements with related parties. These arrangements should operate on an arm’s length basis, with commissions reflecting fair value and adequate intragroup transaction policies being maintained. Asset-management decisions should also remain sufficiently independent, particularly where the appointed asset manager or adviser is affiliated with the shareholder.

Management remuneration may similarly come under scrutiny where leveraged share schemes or other performance incentives could encourage excessive risk-taking or short-term behaviour. EIOPA does not consider performance-related remuneration to be problematic in itself. The relevant consideration is whether those arrangements remain consistent with the sound and prudent management of the undertaking and its long-term obligations.

Ownership structures and prudential risks

Complex ownership structures may make it more difficult for supervisory authorities to identify who exercises influence over an undertaking and to determine how supervisory responsibilities are to be allocated. This difficulty may be more pronounced where several intermediate holding companies or entities established in third-country jurisdictions form part of the acquisition structure.

EIOPA accordingly encourages private equity investors to avoid unnecessarily complex ownership arrangements. Where the structure is complex or opaque, the proposed acquirer may be required to explain its governance mechanisms, identify the entities influencing decision-making, disclose relevant third-party interests and justify each level within the ownership chain. Regular reporting on changes to the private equity group and the financial position of its principal holdings may also be required following the acquisition.

The Supervisory Statement also addresses changes to the insurer’s investment strategy, particularly where its asset allocation is directed towards private credit, unrated credit or other alternative assets. Although these assets may generate higher yields, they may also be more complex, less liquid and more difficult to value.

The supervisory assessment should therefore consider whether the undertaking has the expertise, procedures and governance arrangements required to understand and manage those assets. This includes the ability to carry out, or independently challenge, valuations where the valuation process has been outsourced. The compatibility of the assets with the Prudent Person Principle under the Solvency II Directive, the treatment of their risks within the Solvency Capital Requirement and their relationship with the undertaking’s liability profile should also be examined.

Similar considerations apply to the increased use of reinsurance. Although reinsurance may offer legitimate capital and risk-management benefits, supervisors should look beyond the formal structure of an arrangement and consider the effectiveness of the risk transfer achieved. Contracts providing for high or variable commissions, extensive termination rights or the transfer of investments or investment risks to a related reinsurer may require particular scrutiny. An increased reliance on reinsurance may also expose the undertaking to greater counterparty and liquidity risk.

The manner in which the acquisition is financed will also form part of the overall assessment. Acquisition debt may not sit directly within the regulated undertaking but may instead be held by a parent company, including one established outside the EEA. This does not necessarily insulate the insurer from the resulting risk, particularly where the insurer represents the parent company’s principal source of revenue.

Supervisory authorities should therefore scrutinise the entire financing structure and consider whether the proposed business plan allows the undertaking to generate sufficient value to remunerate both capital and debt while maintaining adequate levels of solvency, liquidity and policyholder protection. The assumptions supporting that structure must be realistic. EIOPA notes, by way of example, that it would not be realistic to assume that acquisition debt can be repaid by applying almost all of the undertaking’s profits towards its repayment.

Supervisors may also pay closer attention to any liens or pledges over the undertaking’s operations or assets. Material changes to its asset allocation, use of derivatives, reinsurance arrangements or the assumptions used to calculate its technical provisions may similarly require further scrutiny. Supervisors may seek a detailed explanation of how cash moves into and out of the business and of any resulting changes to the best estimate, the Solvency Capital Requirement and the undertaking’s own funds. Material changes to assumptions, methodologies or models should be properly justified, evidenced and subject to appropriate governance and validation.

A more forward-looking supervisory assessment

What ultimately emerges from the Supervisory Statement is a more intensive and forward-looking assessment of private equity ownership in the insurance sector. The proposed acquirer should be prepared to explain not only the legal and ownership structure of the transaction, but also the intended post-acquisition business model, investment strategy, governance arrangements, financing structure and eventual exit strategy.

These matters must be considered within the statutory timelines applicable to acquisitions of qualifying holdings and portfolio transfers. EIOPA therefore encourages private equity investors and shareholders to enter into an early dialogue with the relevant supervisory authorities before submitting a formal notification, particularly where the transaction is expected to result in significant changes to the target undertaking’s business model.

Such early engagement should allow potential concerns to be identified before the formal assessment period begins and assist the proposed acquirer in understanding the information and supporting documentation likely to be required.

Overall, the Supervisory Statement makes clear that the regulatory assessment will not end once the acquisition has been approved. Supervisory authorities will continue to consider how the undertaking is managed following the acquisition, including whether its business and investment strategy remains sustainable and whether the interests of policyholders continue to be appropriately safeguarded.